This series of articles will be dedicated to explaining the Ratio Call BackSpread Options Trading. Our previous article set was dedicated to Call Ratio Spread Options Explained. The Call Ratio BackSpread is an exact opposite strategy to Ratio Call Spread, hence the name backspread. Some option traders also call it as Short Call Ratio Spread or Call Ratio Short Spread, but the common term used is Call Ratio Backspread.
As we will shortly discover, the Call Ratio Backspread is a very interesting low risk high profit potential strategy and can generate enormous profits if things go in favor of the options trader taking this Call Ratio Backspread position. Even if the underlying stock goes down, there is still limited loss. However, there are a few things which options trader should keep in mind before getting into Call Ratio Backspread trading position.
Before continuing further, a word of caution about Ratio Spread Options Trading is that these combinations involve taking multiple option positions (atleast 3) at entry and same 3 need to be closed (or exercised) at exit. First challenge may be to get the required options at the desired prices and second mandatory challenge is the cost of brokerage and commission which you end up paying for these multiple options trades. Hence, traders are advised to be aware of these risk parameters and costs.
Example of Ratio Call BackSpread Options Trading ExplainedNow, let's begin with the details of Ratio Call BackSpread Options Trading:
What is the Ratio Call BackSpread Options Trading Position?
As the name suggests, an option trader needs to take multiple call option positions (long and short) in a defined ratio for taking a creating a Ratio Call BackSpread Options.
The ratio is either 1:2 or 2:3 or as decided by the trader based upon his selected options strategy. The resultant payoff function (as explained later in this series) is an unlimited profit, limited loss scenario, ultimately appearing beneficial to the option trader taking this Call Ratio Backspread position.
The strategy is profitable only when the underlying stock prices makes a large move in the upward direction. The position is loss making if the underlying stock price doesn’t move much. If there is a large move in the downward direction, then the loss is limited.
Which scenarios are ideal for trading Ratio Call BackSpread Options?
The Call Ratio Backspread is profitable to trade when the options trader is expecting a big move in the underlying stock price in the upward direction. An increase in volatility is good for this option position. Unlimited profit can be made if the stock price moves in big value in the upward direction and hence this possible scenario makes it ideal for taking a Call Ratio Backspread position.
On the loss side, the option trader will be in loss if the underlying stock price doesn’t move much or remains confined to a narrow region. On the downward side, i.e. a big downward move in the underlying stock price will mean limited loss to the option trader.
For e.g., if say Microsoft is trading at $50 per share (just an example) and in the next 2 months the price of this stock (underlying) is expected to make a big move taking it above $70 or so on the upside.
However, please note that there are multiple other similar options strategies available which also fit the same scenario. Some may come at much lower / much higher risk and different profit potentials. A trader can decide to take a call after understanding each of them.
- Long Straddle
- Long Strangle Options Trading Explained: Example
- Short Put Butterfly Option Trading
- Short Call Butterfly Options Explained
or the simplest of the lot:
- Long Call Option Trading Explained
But do remember that each has its own set of profit and loss positions and each come with its own level of complexity in terms of practical trading. Traders are advised to go through each of the above links above to understand the merits and drawbacks of each and then take a call accordingly.
Here is how the construction of Ratio Call BackSpread is done:
To understand it further, lets move on to Example & Payoff Charts of Ratio Call BackSpread Options